What Separates E*Trade from the Net Broker Pack
The No. 2 online broker keeps adding clients, and better yet, keeps becoming more diversified
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STREET WISE by Sam Jaffe October 13, 1999
We are, everyone tells us, living in the midst of a revolution. The Internet will change our lives, our businesses, our schools, and our families. Such bright visions notwithstanding, the stocks of Internet brokerages are in the dumps. But one of those -- E*Trade (EGRP) -- may be about to prove that its strategy of diversification was the right one, and it may ultimately stand alone as a bright flower in a blighted field.
Analysts knew that this summer would be bad for the Net brokers, but they didn't know how bad. On Oct. 8, Knight/Trimark (NITE), a market maker that gathers 75% of its revenue from clearing trades placed by Net brokers, announced that it suffered a major decline in volume in the third quarter and that its earnings were at least 12 cents lower than the 30 cents per share analysts were expecting. In the quarter that ended in September, its volume of Net trades dropped 5%, vs. the previous year's quarter. Just as bad, the company said that its average revenue per trade suffered a "dramatic drop." That news knocked 10% off the stock, which closed at $25.13 on Oct. 12. Knight-Trimark has now lost more than two-thirds of its market value since reaching a high of $81 in May.
CUT IN HALF. Such bad news for a company that does the manual labor for Net brokers might have set off a stampede of selling among those stocks. Instead, they held up reasonably well. E*Trade has lost 12% since Knight-Trimark's announcement, DLJDirect (DIR) is off 8%, and Ameritrade (AMTD) is down 14%. Even so, such seemingly modest declines reflect the fact that these stocks have already taken a pounding in anticipation of their next quarterly earnings reports. All three are worth less than half what they were in May.
Why the doldrums? There's always a seasonal drop in trading in the summer, but no one thought that volume would shrink compared with last year. The biggest culprit is the correction in Net stocks that began in April and lasted through September. Although these stocks have since recovered a bit, few have regained their earlier highs. A large proportion of trades done by Net brokers are in Net stocks, so it's no surprise that these companies suffer when Net stocks do.
In addition, day trading may be have peaked, hastened by the Net correction. After a year or two, most day traders are finally discovering that there is no free lunch. The good news is that what's left for the Net brokers is a much more stable clientele.
BEYOND BROKERING. There's other good news for E*Trade, which is the No. 2 Net broker after Charles Schwab (SCH) and the largest pure play in the sector. For the past year, CEO Christos Cotsakos has been pushing the concept of diversification to its limits. Partly through acquisitions, E*Trade has already expanded well beyond the stock brokerage business. Its most significant acquisition so far is Telebank, a full-service online bank. In addition, it bought a major position in eLoan and has launched a Japanese branch, E*Trade Japan. "E*Trade is trying to turn itself into a complete financial-services supermarket," says Pacific Crest Securities analyst Tim Butler, who rates the stock a buy. "It's making all the right moves."
Already, E*Trade can boast that 30% of its revenue comes from nontrading-related businesses. The company hopes to raise that figure to 50% within the next two years. Meanwhile, it has launched several low-fee index mutual funds, a business with more stable revenue than stock trading. E*Trade has also invested in an online investment bank, Eoffering, which it hopes will feed IPOs to its clients.
E*Trade has already announced that its trading volume in the third quarter was flat, but analysts will be much more interested in seeing how many new clients the company has added. Pacific Crest's Butler says it should announce that it had 1.5 million customers at the end of September, up from 1.2 million at the end of June. In addition, he thinks revenue will have grown 120% in the third quarter, vs. the year-earlier period.
Analysts are expecting the company to announce a loss of 13 cents a share for the third quarter when it reports on Oct. 13, and they think it won't reach profitability until at least 2001. If E*Trade's diversification strategy continues to boost its revenues, though, its stock should turn up again well before it produces any earnings.
Jaffe covers the markets for BW Online
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